Agenda: Compensation & Benefits - Philosophizing Compensation

Most compensation philosophies have the same basic objectives: to attract, retain and motivate the best employees. But where you go from there determines whether the philosophy is a paper abstraction that sits on a shelf or a vital tool that allows you to equitably and consistently implement your compensation programs.

A well-crafted compensation philosophy "helps tell the story of who you are as an organization and what you value as an organization," says Lynne Sport, director of human resources and administration for the Carnegie Endowment for International Peace, a Washington, D.C.-based, not-for-profit think tank. Sport, who has worked in HR for nearly 20 years in a variety of sectors, including financial services and technology, says the philosophy can help guide HR compensation managers in assessing where the company fits in the marketplace when it comes to trying to attract talent.

A compensation philosophy should provide consistency in three areas: among departments, over time and as the company grows.

"Our comp philosophy is the overarching umbrella that all the compensation programs should fall under," says Karen Macke, senior vice president of compensation and benefits at The Hartford Financial Services Group Inc., a Connecticut-based insurance and financial services corporation with about 28,000 employees in the United States. "If a program falls outside the umbrella, you've got to question if the program is right for the organization."

Having a compensation philosophy can help shield HR professionals from pressures exerted by individual managers who want to customize compensation within their department or division. Without a clear philosophy in place, "you'll always be inundated by the business manager of a profitable business [line] who says, 'I want my own plan,' and you have no way of addressing that," says Paul Shafer, business leader and compensation expert with consulting firm Hewitt Associates in Norwalk, Conn.

The Hartford's philosophy identifies what the company's pay programs are trying to achieve, along with what elements must be consistent throughout the organization. The company does allow for some customization for "unique business situations," Macke notes, such as incentive plans for salespeople. But any unique programs must still align with The Hartford's business strategy and the desired culture of the organization, Macke says. (The company's compensation philosophy appears in the sidebar, at right.)

David Balkin, chairman of the management division at the University of Colorado's Leeds School of Business in Boulder and a compensation expert, suggests that a philosophy should provide a strategy "that links the different compensation programs and pieces together." Basing compensation decisions on historic company practices-in other words, the "We've always done it that way" approach-"doesn't work in a very dynamic economy with global and technological pressures," he says.

Another factor driving the decision to develop a philosophy is the size of the company, says Hewitt's Shafer.

In small companies, such as startups in the technology field, "you have a founder or a small group of senior people who tend to know everybody in the company" and who make "personal" decisions about individual pay, Shafer says. But once a company's workforce grows significantly, "those who are responsible for making the pay decisions oftentimes start losing touch with who all the people are," he notes. "They need a philosophy to be able to govern the program so it can be administered in a fair and equitable manner."

Close Collaboration

While HR generally is in the driver's seat when developing a compensation philosophy, that development often is done in close collaboration with high-level management to ensure executive buy-in and to develop a philosophy that meshes with the company's business objectives.

Kristen Vosburgh, PHR, manager of benefits and compensation at the Cary, N.C.-based business intelligence software company SAS, says that HR and compensation specialists should drive the process, "with feedback and validation from managers."

Sport adds, "HR is clearly in the best position to drive the process. We are the ones who understand the marketplace, have the compensation survey tools, have the knowledge about the jobs, understand the labor market issues and understand the legal issues." But "you can't have a process without senior management buy-in," she notes.

Once HR and top leadership are committed to developing a philosophy, Shafer says he likes to get senior leaders of the organization together to push them to identify and quantify the attributes of a compensation program that they think are important, such as the mix of pay elements. Most senior managers will tell you their philosophy should be to "attract, motivate and retain the best people," Shafer notes, but he adds, "That's too general. It really doesn't give you much guidance." Once the managers identify what they value in terms of compensation, Shafer says his firm works with the client's HR leaders to craft a philosophy statement that is acceptable to management and HR.

The process of considering changes in the philosophy also often is a collaborative process between HR and management. Vickie Davis, manager of compensation and benefits at the Babcock and Wilcox Co. (B&W), a Barberton, Ohio-based energy services company with about 1,100 employees at its U.S. headquarters, says the company's philosophy is reviewed every year prior to the salary-planning process.

While business leaders focus on possible changes relating to business objectives, it's HR's job to examine potential resource issues that might, for example, require a company to consider paying a premium for talent. If there was a scarcity in the available labor pool that would prompt a change in compensation philosophy, HR leaders "certainly would be the catalyst for that because we would be aware of it first," Davis notes.

Shafer urges HR managers to step back when considering their philosophy to look at the broader framework of attracting and retaining employees. "You should put a compensation philosophy within the framework of your talent philosophy," he says, by assessing fundamental issues such as whether the company is trying to develop home-grown talent or invest in attracting outside talent.

"It's cheaper to grow your own tomatoes than to go buy them in the market," Shafer observes. "But if it's the middle of winter and you need a tomato, you really don't have much choice."

HR needs to review how the company currently is evaluating jobs and paying employees, including consideration of market positioning of the jobs, and assess potential variances in pay compared to the market. HR managers also need to consider if current pay practices are working or whether adjustments are needed to attract and retain employees based on current wage rates, Vosburgh notes. Some of the more obvious signals that pay practices aren't working are employee turnover and an inability to successfully hire top job candidates.

Company culture and business needs also must plug into the analysis, says Vosburgh. For example, she notes that at SAS, which employs about 5,300 people in North America, "We do aspire to pay our people competitively, but there is a cultural need to be egalitarian," so that need has shaped the compensation philosophy.

"Except for certain [research and development] and critical jobs where we may target base salary above the market median, we look at the local market median for the base salary," explains Vosburgh.

'Intangible Compensation'

Innovative companies are developing philosophies that communicate all that their workplaces have to offer. Vosburgh says SAS's philosophy focuses only partially on pay. "We have not given up on the paycheck. Base salary is important," she says. "However, our benefits, annual company contribution to profit sharing, a 401(k) safe-harbor contribution and on-site amenities are also a significant portion of the package."

The University of Colorado's Balkin notes that SAS has been included on many "best places to work" lists in part because of this broader compensation philosophy that emphasizes total rewards.

Similarly, as a not-for-profit organization, the Carnegie Endowment for International Peace does not offer high pay, Sport notes. What it does offer is the "intrinsic value" of working for an organization that emphasizes quality of life and robust benefits, including generous retirement and vacation programs. "We place a really high value on quality of life," she says, suggesting that a pleasant work environment perhaps should be considered "intangible compensation."

'Transparency and Clarity'

Once a philosophy is in place, many companies work hard to communicate it to their employees across the board. "For us, transparency and clarity in communication are critical to employees," says The Hartford's Macke. "The philosophy that helps define the comp program can't be motivating to employees if it isn't understood."

At B&W, enhanced communication turned out to be crucial in getting managers and employees to understand the company's new emphasis on pay for performance, which resulted in better performers receiving a larger proportion of salary and bonus dollars.

"Managers had difficulty embracing the philosophy at first," says B&W's Davis. Although the pay-for-performance system had rolled out several years earlier, Davis says it became clear by 2002 that more aggressive communication measures were needed to bring about increased acceptance of the approach.

Davis worked with B&W's communications staff to write a basic philosophy statement and to post it on the company's intranet. HR managers also began coaching line supervisors and providing them with talking points to help them in salary-related discussions with employees. (See B&W's
compensation philosophy.)

"The driving force behind putting [the philosophy] out there is the feeling that the employees needed to see it in writing, needed to understand it, so that they would understand it wasn't arbitrary," Davis says. Managers have achieved "a better comfort level" in discussing compensation with employees but, she acknowledges, it has been an evolution.

"We've gone from a culture that didn't talk about compensation to one that does," she notes. Employees "may not agree with how it has impacted them, but they do at least understand that it's not arbitrary, there is a process, there is a philosophy that everyone is trying to adhere to."

Possible Problems

But communicating openly with employees could leave companies vulnerable. The University of Colorado's Balkin, who has appeared as an expert witness on behalf of plaintiffs in pay discrimination cases, urges caution when considering just how open to be. The philosophy could come back to haunt the employer if the employer has failed to abide by it, he suggests.

In a litigation setting, "If I know what the compensation philosophy is and I see [an employee] who was treated as an exception to that policy, I would use that as additional evidence that discrimination took place," he says. "If you don't act consistently [within an open system], there's a liability there."

In addition, if those you expect to communicate the philosophy to the rank and file are not up to the task, think twice about how far you spread the word, says SAS's Vosburgh. "If the managers are not equipped to effectively communicate the philosophy, then the philosophy should be limited to management only," she says, adding, "Managers should possess basic compensation knowledge before a stated philosophy is publicized companywide."

Compensation often is a hot-button issue among employees, and the compensation philosophy should be constructed to address potential problems. The reality of many workplaces is that some jobs are valued more, and therefore are compensated better, than others.

When employees ask why jobs are ranked differently, "those are hard, hard questions to answer," says Sport. "But if you put together a good philosophy, they're very defensible." When she worked at a boutique financial services firm, she says, "we placed a very high value on talent, and that talent was unique." As a result, the key people in financial positions were very well compensated in terms of salaries and bonuses, while other employees were paid about market rate.

"But it was justifiable," Sport notes, because the compensation philosophy emphasized the value of those employees. "Without those key financial people, we wouldn't be in business."

Charlotte Garvey is a freelance writer, based in the Washington, D.C., area, who reports on business and environmental issues.